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Mortgage risk is on the rise, but experts say that's O.K.

Published: 03 Aug 2017

Over the past year, lenders have slowly but surely loosened the restrictions on purchase mortgage restrictions, which they've held historically tight for about a decade. This comes both as the economy continues to recover (leading to higher pay and lower unemployment) and mortgage rates rise, making buyers a much greater force in the mortgage market than current owners looking to refinance. And with more buyers necessarily comes greater risk, but the general consensus is that risk has been so low for so long that this is just the market getting back to normal.

Mortgage risk for lenders is actually on the rise on a number of fronts. For one thing, the likelihood of mortgage defects such as fraud, errors and misrepresentations - which title insurance can help to protect against - had been rising considerably for seven straight months through the end of June, according to the latest Loan Application Defect Index from the First American Financial Corporation. In all, the rate of defects, fraud and misrepresentation rose 1.2 percent from May and 16.7 percent on an annual basis.

However, this may not actually be a huge point of concern for many institutions, because that risk is still well below all-time highs, and seems to be a natural result of the changing mortgage sector as a whole.

"The market shift toward more purchase mortgages, coupled with rising rates and tight inventory, is generating the consistent upward trend in defect risk," said Mark Fleming, chief economist at First American. "Purchase transactions are inherently more at risk of defects, fraud and misrepresentation, and the pressures resulting from one of the strongest sellers' markets in recent memory compounds the risk of an error on a loan application."

Mortgage risk is on the rise, but it may just be a sign of a relatively healthy market overall.

Another type of riskAt the same time, default risk is also on the rise, particularly as more first-time buyers come into the market and get their loan applications approved, according to the latest Mortgage Risk Index from the American Enterprise Institute's International Center on Housing Risk. While the overall risk of default on home loans originated between September 2012 and April 2017 - the most recent month for which complete data is available - stands at 12.7 percent (up only slightly from the 12.6 percent seen in April 2016), risk among first-time buyers is considerably higher: 16.2 percent, and up from 15.8 percent a year earlier.

The trend continuesHowever, because first-time buyers make up such a sizable slice of the market, and lenders continue to broaden standards, risk factors aren't likely to change any time soon, according to former member of the Federal Reserve Board's Consumer Advisory Council, Kenneth Harney. Lenders - with the help of Fannie Mae, Freddie Mac and the Federal Housing Administration - are making it easier for those with lower credit scores and smaller down payments to get approved, fueling the current sellers' market for some time to come.

However, with rates and prices both expected to keep rising through the end of the year, the sooner buyers can get into the market, the more likely they will be to lock in the best deals available.